Paying for Katrina Cleanup...One Gallon at a Time

The government’s (taxpayers') clean up cost for Hurricane Katrina is mind-boggling. Estimates run as high as $200 billion. This is in addition to billions in uninsured losses and what insurance companies are on the hook for. Some now say $35 billion.

All told, Katrina (and Rita) could cost a quarter trillion dollars in direct costs, to say nothing of increased energy costs, unemployment, and other indirect costs to the nation’s economy.

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No previous U.S. natural disaster comes close. $200 billion is well beyond the financial liability from mere acts of God and all the way into acts of man territory.

It’s debatable if the government should cough up that sort of cash. What sort of precedent does it set for future, possibly more expensive, catastrophes? Will the heavily indebted government then have to shrug and say, “Sorry, too bad this didn’t happen when interest rates were lower and our credit was better?"

Coming up with a way of footing this bill is critical to keep the government on sound financial footing for future unexpected needs.

There are three ways to both pay for any massive new government spending and Take Care of Business (TCB): Tax, Cut, or Borrow.

Republicans prefer to cut other spending (historically, if not presently). Democrats prefer to raise taxes. Politicians prefer to borrow because both of those solutions are politically unfavorable.

Borrowing to pay for Katrina cleanup will turn $200 billion into a $400 billion liability for future generations. This is the equivalent of renovating your house and paying for it with your child’s credit card.

Borrowing to spend can over stimulate an economy and cause inflation — a current worry on Wall Street. Why? It’s helicopter money dumped down on people who spend rapidly with no decrease in demand elsewhere in the economy and no quick increase in supply.

This is what is sometimes called for in a recession. In fact, we did it a few years ago. But we don’t need another stimulus package — home and energy prices have gone up enough already, thank you.

The president is now seeking spending cuts (it’s about time) that could pay for some of the costs. Another chunk will invariably come from borrowing. But what about raising taxes to pay for the rest?

A special “Katrina Tax” is in order. We all hate taxes, but do we hate taxes more than helping those hurt by Katrina? If so, then the government shouldn’t spend a nickel since we all want to help without really sacrificing anything. Do you donate to charities with other people’s money?

I propose a new Katrina gas tax. $1 per gallon of gasoline for 100 days. This would be on top of the government’s current 18.4 cents per gallon tax (on top of state taxes as well).

As a nation we consume around 380 million gallons of gas a day. Since demand for gas could drop with higher prices, figure 360 million with the tax. Over 100 days the government would rake in some $36 billion.

Two obvious negatives: 1) gas taxes are like sales taxes and are regressive, meaning they hurt the poor the most. This is true, but then, getting the $36 billion from the masses is the best way to counter the inflationary effect of spending billions elsewhere. 2) Gas prices are already sky-high; adding another buck to the price is unacceptable. Not true!

Gas prices are high because demand has grown faster than supply. This was going on way before Katrina. The hurricane hit gasoline refining capacity hard — harder than production or actual pumping of crude oil. Prices had nowhere to go but up until demand falls to meet lowered gas supplies.

Here is a rough example: If we consume 380 million gallons a day, and maximum gas refining capacity is 390 million gallons, we’re going to have high gas prices but no major problems. If a hurricane damages refineries so we can only refine 360 million gallons, prices have to move to a level that demand drops to 360 million gallons — or there would be shortages. Let’s say that new market equilibrium price is $4.00 per gallon. What happens if we get a new $1.00 gas tax — $5.00 gas? Nope.

$5.00 gas could drop demand to say, 330 million gallons a day. Now we’d have a mini supply glut and prices would come down, back to around $4.00! There can only be one price at the pump after a hurricane induced supply disruption, the price that leads to demand falling to new lower supplies.

Imagine the government repealed the current gas tax instead, to “help” motorists given the high gas price post Katrina. Would the price fall? No, because the price can’t fall below a level that creates demand above 360 million gallons.

Look at it this way, if the government doesn’t add a $1 tax, refineries and oil companies are going to make that much more money until more supply comes online (at least the ones that didn’t lose much capacity in the hurricane). Don’t believe it? Wait till you seen refiners', like Valero (VLO), profits in a few months.

Do you want the government to make the extra $36 billion to pay for Katrina, or the oil companies (already earning all-time record profits before Katrina)?

In a normal market with no supply disruption such a government tax would increase prices — just look at Europe and Japan where gas prices are always higher than our post Katrina levels thanks to huge taxes.

Normally, its best if the government doesn’t mess around with the profits of a free market. Friends of mine in the oil business tell me (from their historic six story brick townhouses — homes with names) these windfall profits are what leads to more supply years in the future, they are the incentive to drill or build expensive refineries.

If an unpredictable government steps in and steals profits with windfall profit taxes every time the going gets good, why bother? Nobody stepped in to help the refinery business when they were in a two decade profit slump.

There is truth to this, but I question why so few oil companies seem to be spending money on new production or refining capacity nowadays, but somehow have billions to spend buying each other out to control more existing supply. Maybe they are fighting government and environmental non-free market behavior with a little of their own.

Jonas Max Ferris is a regular contributor on "Cashin' In" (Saturdays at 11:30am ET and Mondays at 5:30am ET) and is co-founder ofMAXfunds.com.